Higgins, looking to complete a double in China after triumphing in the Shanghai Masters last month, led 2-0 after breaks of 71 and 73 but Cao fought back spectacularly to take the next five frames.
The four-time world champion looked to be on the comeback trail when he clinched the next - missing out on a 147 in the process after failing to pot the 11th red - but his 22-year-old opponent held his nerve to wrap up the biggest win of his fledgling career.
The world number 66 told worldsnooker.com: "I'm very excited to beat such a great player. John started well but then he faded. Overall I am very satisfied."
Higgins said: "It's a big tournament so I'm gutted to go out in the first round. I started well but then I missed a lot of chances and I didn't deserve to win."
Cao will next take on either Mark Allen or Robert Milkins in the last 16 and a match against the former could prove interesting.
After being defeated in the first round of this year's World Championship, Allen accused the Chinese of dishonesty, claiming Cao failed to declare an illegal push shot when leading 5-4.
The Northern Irishman further alleged that "blatant cheating" might be "a bit of a trait for the Chinese players" before issuing an apology for his remarks.
There was almost another upset as former Masters and UK champion Matthew Stevens was taken to a final frame by Zhao Xintong.
The 15-year-old beat former world champion Ken Doherty on Sunday and won three successive frames on Monday to level the match at 4-4.
A 50 break took Stevens ahead again only for Zhao to respond with 66, but a run of 44 helped the Welshman win the decider.
"At 4-1 I thought it was going to be an early night, but then he gained some momentum and in the last frame I thought I was going to lose," Stevens said.
"He is a fantastic player, the best wild card I have seen. He's got raw talent and a good attitude."
World number one Mark Selby saw off Ali Carter 6-3 with breaks of 63, 51, 50 and 59. He will meet either Ricky Walden or Lu Ning, who edged out Barry Pinches 6-5 in a scrappy encounter to reach the first round proper.
Dominic Dale won five of the last six frames to beat Graeme Dott 6-3, a run which featured breaks of 74, 108 and 61. The Welsh player next faces 14-year-old wild card Lu Haotian.